We are proud to support Seattle University’s 6th Annual Northwest Marijuana Law Conference taking place on Friday, November 16. Josh Ashby and Sativa Rasmussen are the program’s Co-Chairs and will lead the conversation, bringing together experts from the law and the industry to provide critical focus and frameworks.

Ben Pirie will present on “Updates on Marijuana Law in Washington, Litigation, Dispute and Financial Issues” at 9:45 a.m.

Justin Hobson will present on “The Impact of Oregon, Canada and California on the Legalization of Marijuana Across the United States” at 11 a.m.

Other topics include:

  • Cannabis and the Constitution
  • The Impact of the 2017 Changes in Tax Law
  • Greening the “Green”: Sustainability in Cannabis Cultivation, Processing and Distribution
  • Growing Investments by Banks and Big Money in the Cannabis Industry
  • Ongoing Issues of Employment Law in the Cannabis Industry
  • Cannabis IP: Federal and State Protection of Trademarks and Other Intellectual Property

Date: November 16, 2018

Time: 8:30 a.m. to 5:15 p.m.

Cost: $225 General Registration | $195 Seattle U Law Alumni | $150 Non-Attorney

Credits:  Approved for 7.0 CLE Credits

(Live webcast and in-person options available.)

For more information and to register, visit the event website.

The Food and Drug Administration (FDA) has issued an announcement seeking public comment on the “abuse potential, actual abuse, medical usefulness, trafficking, and impact of scheduling changes on availability for medical use” of cannabis and several other substances now under international review.

This announcement comes in response to the upcoming meeting of the World Health Organization’s Expert Committee on Drug Dependence (ECDD) in Geneva, Switzerland in November. The ECDD will be evaluating whether to recommend that certain international restrictions be placed on the plant.

Under current U.S. federal law as well as global drug policy agreements, cannabis is classified in the most restrictive category of Schedule I. Consequently, nations who are signatories of such drug control treaties are expected to treat cannabis as an illegal substance, not that this has stopped countries such as Canada and Uruguay from legalizing cannabis nationwide.

Earlier this year, ECDD determined that cannabidiol (CBD), a component of cannabis shown to have medical benefits without intoxicating properties like other cannabinoids such as THC, should not be scheduled under international drug control conventions.

“CBD has been found to be generally well tolerated with a good safety profile,” the UN body found in its critical review. “There is no evidence that CBD as a substance is liable to similar abuse and similar ill-effects as substances…such as cannabis or THC, respectively.” The Committee went on to recommend that preparations considered to be pure CBD should not be scheduled.

This determination confirms a statement by the FDA that CBD should be completely removed from federal control. Specifically, the agency found that CBD has a “negligible potential for abuse” and has a “currently accepted medical use in treatment.”

Despite this, because of the international drug treaty obligations, the FDA conceded that the substance should be placed under the least-restrictive category of Schedule V.

Having said that, in its analysis to DEA the FDA noted that “if treaty obligations do not require control of CBD, or if the international controls on CBD change in the future, this recommendation will need to be promptly revisited.”

The FDA’s statement that was released in May preceded the ECDD determination that CBD should not be globally scheduled, and was part of the federal government’s approval and rescheduling last month of CBD-based drug Epidiolex, which is used for severe epilepsy disorders.

The ECDD has also agreed to undergo an in-depth critical review of the marijuana plant and its resins and extracts, including CBD and THC. That new review is what triggered the FDA’s request for public comment.

For now, the FDA will be accepting comments on cannabis as well as the other substances currently under review until October 31, 2018. Interested parties can submit written comments here.

Just in case you missed it, Rep. Earl Blumenauer (D-OR) sent a memo to Democratic congressional leaders on Wednesday outlining a comprehensive plan to legalize marijuana in the United States as soon as 2019. You can read the full text here, and we couldn’t have said it better ourselves. It’s hard to overstate the importance of the comprehensive federal marijuana reforms outlined by Rep. Blumenauer (up for reelection next month — Lane Powell endorses civic engagement), which would address banking, taxation, safe access for veterans, criminal justice reform, states’ rights and scientific research. With Canada positioning itself recently as the world leader on sensible cannabis policy, the question is — why not us?

A few months ago, we chronicled a suit that Josephine County brought against the State of Oregon, which challenged the legality of the state’s marijuana laws. On August 30, Federal Magistrate Judge Clarke recommended dismissal of the lawsuit. In succinct fashion, Judge Clarke noted that Josephine County lacks standing to sue the State of Oregon on constitutional grounds because the county is a political subdivision of the state. As additional grounds for dismissal, Judge Clarke explained that the state has not (yet) placed any substantive limitation on the county’s regulation of marijuana, such that there is no live controversy for the court to address.

Judge Clarke closed by noting the hypocrisy of the county’s lawsuit:

Finally, on a practical rather than legal note, the Court is unpersuaded by Josephine County’s argument that the State is “requiring” it to “aid and abet a federal felony.” The County has provided no evidence to the Court that it has attempted to ban any and all marijuana use and production, as would be theoretically required by full compliance with the [Controlled Substances Act]. Instead, the County merely seeks to limit the use and production in rural residential zones, while continuing to allow marijuana use and production in other instances. Apparently the County is only worried about aiding and abetting federal felonies on certain kinds of land and not others.

Judge Clarke leaves open two important substantive issues — whether Josephine County can retroactively prohibit marijuana production in rural residential zones and whether the federal Controlled Substances Act preempts state level marijuana laws. His Report and Recommendation will be referred to a federal Article III judge for review — the parties have 14 days to submit objections.

The White House Office of National Drug Control Policy (ONDCP) recently released “An Initial Assessment of Cannabis Production, Distribution, and Consumption in Oregon 2018 – An Insight Report.” The report “does not purport to be a policy evaluation or policy performance review; rather [the] assessment provides a verifiable analysis of assorted information and data.” A review of the data and its presentation raises more questions than it answers. The assessment presents data in a way that conflates Oregon’s adult-use, medical and black markets. As a result, it is challenging to determine what, if any, policy response might be appropriate.

The U.S. Attorney for the District of Oregon provided a statement in response to the assessment. The statement describes the production, distribution and consumption in Oregon as “out of control” and suggests, “state officials should respond quickly and in a comprehensive manner to address the many concerns raised.” The U.S. Attorney requests, “continues to be for transparency, responsible regulation, adequate funding, and a willingness to work together.” He further adds, “[i]t’s time for the state to wake up, slow down, and address these issues in a responsible and thoughtful manner.”

Fair enough. So let’s take a look the assessment and see how meaningful the current data really is. The assessment’s key findings include:

  • The Oregon Burn Center spent $9.6 million for initial acute care treating impatient burn victims from July 2015 through January 2018 that related to cannabis extract production.
  • During the same period, law enforcement investigated 64 cannabis processors, 21 of which resulted in fire or explosion.
  • A mature cannabis plant consumes 22.7 liters (6 gallons) per day.
  • A single kilogram (2.2 pounds) of finished flower requires 5.2 megawatt hours of electricity — this is equivalent to running a 1,000 watt grow light 24 hours a day for 225 straight days!
  • Cryptocurrencies such as bitcoin and ether are used for cannabis transactions.
  • A glut of cannabis stockpiles stemming from overproduction caused a 50 percent annual price drop since 2016.
  • As of 2018, only 31 percent of available cannabis inventory was distributed, leaving 69 percent unconsumed within the adult-use program.
  • Illicit cannabis cultivation on public lands persists unabated, despite the state-sanctioned adult-use market.
  • Illicit out-of-state distribution persists after the emergence of the state-sanctioned adult-use market.
  • Oregon’s annual production capacity far exceeds its estimated annual consumption demands — there is one grow site for every 19 users (probably includes both medical and recreational grows, but not adult-use home grows).

There is an obvious elephant in the room.  The production and sale of cannabis remain illegal under the Controlled Substances Act, and the Attorney General has made his views on the state legalization of marijuana quite clear. So there might well be an inherent bias as a result (similar to EPA’s recent conclusion that larger cars will reduce fatalities and fuel consumption because people will drive less because fuel will be more expensive and they can carry more groceries in their cars). That said there is the obvious problem of cannabis demand throughout the U.S., including in states without medical or adult-use programs. Prior to its medical and adult-use programs, people were illegally producing and exporting cannabis from Oregon. Few would question the conclusion that Oregon has, and will continue to have, an export problem when there is money to be made from illegally producing and selling cannabis.

Still, at least two of the data points stand out as possibly incorrect or at least misleading given the report’s statement that they constitute “verifiable analysis of assorted information and data.” The first is the statement that a single mature plant consumes, on average, 6 gallons of water per day. The second is that it takes approximately 5.2 megawatts of electricity to produce a single kilogram of (indoor) finished flower.

Digging deeper into the assessment, it notes, “definitive information varies about the water needs of cannabis cultivation with estimates ranging widely from 1 to 15 gallons daily.” The six gallons per day figure comes from a California study. That study relied on “high-resolution aerial imagery to estimate the number of marijuana plants being cultivated in four watersheds in northwestern California” and “estimated the water demand of marijuana irrigation.” However, the water estimates “were based on calculations from the 2010 Humboldt County Outdoor Medical Cannabis Ordinance draft.” I was unable to locate a specific water estimate in that ordinance. It simply states, “the cultivation of marijuana in areas not served by public water systems may result in large, unregulated withdrawals of water from creeks, streams, and rivers.” It remains unclear where the 6 gallons per day figure actually comes from, how accurate it actually is, and whether it equally applies to indoor and outdoor operations, which are in compliance with state law.

The claim that it takes approximately 5.2 megawatts of electricity to produce a single kilogram of finished flower comes from a 2017 paper titled “High Time to Assess the Environmental Impacts of Cannabis Cultivation.” The paper does not analyze electricity use, but rather states “it has been estimated that the power density of marijuana cultivation facilities is equal to that of data centers and that illicit grow operations account for 1% of the U.S.’s average energy use.” The paper cites a 2012 paper titled “The carbon footprint of indoor Cannabis production.” A subsequent paper titled “Trends and Observations of Energy Use in the Cannabis Industry,” citing the 2012 study, notes the author “calculates that it takes approximately 13,000 kWh per year to operate a standard production module that is 4’x4’x8’. This is based on a production cycle of 78 days, for 4.7 cycles per year, and simple assumptions about the equipment capacities and use.” There is an obvious leap between a small 4’x4’ grow space and larger indoor production facilities that employ LED lighting. Indeed, the author of the subsequent paper suggests that, “falling product prices will drive the need for more competitive operating costs, which will largely be presented in the form of energy efficiency.” There are arguably energy savings from larger indoor grows, outdoor production and the use of indoor greenhouses that rely on light deprivation techniques.

My view is that the U.S. lost the federal war on all drugs long ago, not just cannabis. Nevertheless, the law is the law and, regardless of Oregon legalization, we cannot permit growers to operate on federal lands. OLCC licensed businesses must support efforts to eliminate market participants that do not follow the rules, and they must take better care to ensure that their product does not enter the black market. Lastly, OLCC enforcement also needs to be stepped up — following adequate funding from the State Legislature — if for no other reason than to prevent further wrath of the federal government.

Most of our readers probably concur that the U.S. Attorney’s call to Oregon to “wake up” is misplaced. Our federal anti-drug resources would be far better directed at the community-destroying opioid crisis, but that seems unlikely to happen under the current Attorney General unless and until Congress gets its act together to pass the STATES Act. Evidence already exists that medical marijuana (1) reduces the daily doses filled for opioids, (2) reduces opioid overdose deaths, and (3) facilitates the substitution of marijuana for opioids. Removing cannabis from the Controlled Substances Act in states where the people and the local government have decided that there are larger public health issues to worry about would allow our federal government to not only respect public sentiment regarding cannabis but also liberate funds do help those affected by life-destroying pharmaceuticals.

Justin Hobson made a guest appearance on episode #6 of CFN Insider’s “Profit From Cannabis” podcast. The episode, entitled “The US Cannabis Marker: New Promise, Persistent Constraints,” covers:

  • The FDA’s approval of GW Pharma’s Epidiolex,
  • Impact of rescheduling cannabis and DEA’s rescheduling possibilities (isolate vs. cannabis plant),
  • Resulting investment plays (cannabinoid drug developers, hemp extracts), and
  • A legalization roundtable that discussed how state cannabis programs are faring under the Trump Administration.

Hobson commented on the growing risks investors’ face since the rescission of the Cole Memo, the increased scrutiny that applicants have observed from the Oregon Liquor Control Commission, and the industry’s problem with product diversion. Have a listen!

A significant tax bill may await RICO plaintiffs involving cannabis lawsuits because in most cases the plaintiffs will be taxable not only on amounts recovered but also on the amounts spent on lawyers and court costs.

We recently discussed the latest in a series of Oregon RICO cases that generally involve property disputes. Plaintiffs and plaintiff attorneys find RICO cases attractive given the status of cannabis under the Controlled Substances Act and the availability of treble damages plus attorney’s fees. The most recent complaint alleges property damage from “noxious” odors and illegal activities that resulted in reduced property values.

There is at least an argument that the dollar value attributable to these items is zero or some nominal amount. One of the earlier RICO cases settled out of court. There are no public details of the agreed upon settlement. However, a number of the defendants successfully fought the cases against them and obtained dismissals. The remaining defendants probably found it cheaper to settle than face a drawn out legal battle. It is probably fair to say that a significant amount of the settlement went to pay attorney’s fees. This conclusion is, in part, based on the fact that the same attorney has represented multiple plaintiffs in cannabis RICO claims. While these claims might provide plaintiff attorneys a meal ticket, the plaintiffs themselves might be left holding the bag when they determine their federal income tax liability.

Specifically, section 61 of the Internal Revenue Code of 1986, as amended (“Code”) defines “gross income” for federal income tax purposes as income from “whatever source derived.” This means that the general starting point for determining taxable income is that any amount received is taxable to the recipient. Furthermore, under the “assignment of income” doctrine, a taxpayer is often taxed on the gross amount recovered, even if the taxpayer does not directly receive custody or take possession of the income amount. Thus, in the typical contingent fee arrangement, a plaintiff might agree to pay an attorney 40 percent of any damage award. Any settlement is generally paid to the plaintiff attorney’s client trust account where 60 cents of every dollar goes to the plaintiff and the remaining 40 goes to the plaintiff’s attorney. For tax purposes, this is generally treated as the plaintiff receiving the entire dollar and spending 40 cents for legal fees notwithstanding the contingency fee arrangement.[1]

Several code provisions provide for excluding certain types of damage awards from taxable income. For example, section 104 of the Code excludes from taxable income amounts received that are on account of personal physical injury or physical sickness. Those income exclusion provisions are not likely to apply in these RICO cases.

Deductions from gross income are a “matter of legislative grace.”[2] Trade or business expenses are generally deductible under section 162 of the Code — subject to denial under section 280E for any trafficking business. Alternatively, section 212 of the Code allows a deduction for all ordinary and necessary expenses paid or incurred for the production of income and for the conservation of property held for the production of income. Regulations under section 212 note that expenses paid or incurred for conservation of property used by taxpayer as a residence are not deductible under section 212, but are deductible if the property is used for the production of income (e.g., rental property).

Prior to 2018, section 212 expenses were considered miscellaneous itemized deductions that were subject to a minimum floor, typically two percent of adjusted gross income. If the expenses did not exceed the floor, then they were not deductible to the taxpayer. However, code section 67(g), added by the so-called Tax Cuts and Jobs Act of 2017, temporarily eliminates the availability of such miscellaneous itemized deductions even over a taxpayer’s 2 percent floor. Section 165 casualty losses were also materially limited by the same “tax reform” — now allowing itemized deductions for such losses only to the extent they exceed 10 percent of a taxpayer’s adjusted gross income.

Section 62 of the Code provides several so-called above-the-line deductions. Above-the-line deductions are not miscellaneous itemized deductions and subject to the temporary elimination noted above. They remain deductible for federal income tax purposes. Section 62(a)(2) provides a deduction for attorney fees and court costs involving most discrimination lawsuits, and claims under chapter 37 of title 31 of the United States Code. However, RICO claims typically fall under section 1962 of title 18 of the United States Code. Therefore, the deduction available under section 62 for legal fees in certain cases would not be available in connection with cases involving RICO damages.

In sum, if the RICO claims relate to property used for personal purposes (e.g., as a residence), then no deduction should be available under sections 162, 165 or 212 for any legal fees incurred. Indeed, whenever RICO plaintiffs are not engaged in the active conduct of a trade or business they probably cannot deduct their legal fees or even offset the gross amount recovered in such suits by legal fees retained by their lawyers.

Hypothetically, a plaintiff could settle a RICO case for a nominal amount of say $10,000 plus attorney’s fees of $50,000. The taxpayer-plaintiff probably needs to recognize the entire $60,000 as taxable gross income under section 61 and in many cases will not be entitled to claim a deduction for the $50,000 paid (or deemed paid) to the attorney. Assuming a 40 percent combined federal and state tax rate on the $60,000 of income, the tax due is $24,000, which significantly exceeds the plaintiff’s net proceeds of $10,000. The irony of this situation is that it is the exact problem many cannabis businesses face under section 280E — the taxpayer’s net income is less than the tax liability.

The takeaway? Potential RICO plaintiffs should consult with a tax advisor before pursuing RICO claims. Failing to do so could leave them with a tax debt exceeding a damage award or settlement amount.

[1] Commissioner v. Banks and Commissioner v. Banaitis, 543 U.S. 426 (2005).

[2] Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).

Like coworkers to donuts, the cannabis industry has attracted a host of adjacent industries that interface with the business of marijuana in one way or another. Some, like security, cash management, and analytical services, support the industry in ways that are integral to its success. Others . . . do not. Enter the Oregon attorney who has been busy of late filing civil RICO complaints against what at this point constitutes a significant minority of Oregon cannabis businesses.

The joys of civil RICO claims came onto the Oregon industry radar in 2017, when over 70 people and entities were sued by an attorney who owned property adjacent to several of the defendants’ businesses. The lawsuit alleged that the activities of marijuana businesses on adjacent properties had diminished the value of the plaintiff’s land. This was not in and of itself novel — cannabis businesses face nuisance-type complaints from neighbors with some regularity. Last year’s innovation was the addition of federal civil RICO claims to a garden-variety neighbor dispute, following the measured success of this tactic in a 10th Circuit case out of Colorado. The first case settled earlier this year.

While the terms of the settlement are confidential, it seems to have been favorable enough that RICO-infused property disputes have become a cottage industry. To that end, two other civil RICO complaints have been filed, with the latest coming in this past Friday. Filed on behalf of a property owner in Sandy, Oregon, the complaint alleges diminution to the value of the plaintiff’s property due to odors, alleged harassment, and the undesirability of living next to an “illegal drug manufacturing site that might easily explode and set the whole neighborhood on fire.”

The merits of the claims aside, the complaint appears to follow an emerging pattern in anti-cannabis litigation: getting nuisance-based neighbor disputes into federal courts using the federal prohibition of cannabis and “Reefer Madness”-type scaremongering. And while some of the more florid language in the complaint is amusing, civil RICO actions are quite serious, with the potential for triple damages and attorneys’ fees if a plaintiff prevails. We’ll be posting updates as we work through the details of the complaint. In the meantime, be nice to your neighbors, and take lawsuits like this seriously. If you or someone you know is affected by this kind of lawsuit, we can help. Contact our experienced litigation team today to discuss your options.

On July 3, the New York Department of Financial Services (“DFS”) issued its “Guidance on Provision of Financial Services to Medical Marijuana & Industrial Hemp-Related Businesses in New York State (PDF).” In the memorandum, DFS Superintendent Maria T. Vullo examines the current banking issues facing the state-legal marijuana businesses and states (in our view correctly) that:

Forcing medical marijuana and industrial hemp businesses to operate solely with cash creates a public safety issue, as cash intensive businesses and their suppliers, employees and customers become targets for criminals. Large amounts of cash distributed outside the regulated banking system is unacceptable and creates risks to the companies, and their employees and business partners. Further, large scale cash operations impede tracking funds for tax and anti-money laundering purposes. None of this is necessary. Positions taken by the federal government are only exacerbating these problems, rather than remedying them. New York must act.

Notwithstanding DFS’ guidance (including its reference and reliance on the rescinded Cole Memo), banks are likely to be reluctant to respond to the Superintendent’s encouragement for “New York State chartered banks and credit unions to consider establishing banking relations with [New York state sanctioned] marijuana-related business.” Most banks continue to have concerns that the federal regulators, including the FDIC, will not sanction this activity. This is evident in states that have enacted recreational-marijuana programs, where concerns about federal regulators and burdensome compliance requirements limit options to a handful of banks charging onerous rates for basic services. In any event, this memo represents a significant marijuana banking “shot across the bow” to federal banking regulators by the principal bank regulator of the state that serves as the center of the country’s banking business.

As our regular readers are aware, Senators Warren and Gardner introduced a bi-partisan bill in the Senate for the federal government: (1) to generally defer to state laws legalizing marijuana and (2) to effectively allow all banks to provide services to legal cannabis businesses in the same way that they treat other legal businesses (STATES Act, S. 3032). S. 3032 has been read twice and was referred to the Senate’s Judiciary Committee when it was introduced on June 7. An identical bill was introduced in the House (H.R. 6043), also on June 7, and was referred to the House’s Judiciary and Energy and Commerce Committees on the same day. No action has been taken on either bill since they were introduced.

Earlier this month, Congress continued to avoid providing bank access to state-legal cannabis businesses by voting against measures in appropriations bills that would have prohibited bank regulators from using federal funds to punish banks that provide bank services to state-legal cannabis businesses. This failure by Congress to allow cannabis business access to the banking system continues to cause serious business and safety problems for state-legal cannabis businesses.

With the midterm elections now coming into clear view, and with dramatic divisions in both houses of Congress, it appears unlikely — at the present time — that Congress will take any steps to solve this cannabis banking problem. It also remains unclear if, without Congressional action, the federal banking regulators will take any useful steps in the area, especially in light of the rescission of the Cole memo by Attorney General Sessions.

We will continue to follow and report on this, but unless an imaginative and scalable solution is found, the risks (including to public safety) and difficulties in dealing in an all-cash business is likely to be a significant hurdle for state-licensed  cannabis businesses.